Trade Signals – The 10-year Bull Market (Longest in History) May Have Peaked

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By Steve Blumenthal
March 13, 2019
S&P 500 Index — 2,799

Posted each Wednesday, Trade Signals looks at several of my favorite stock, investor sentiment and bond market indicators. Market trends persist over time and stem from changes in risk premiums or the amount of return investors demand to compensate them for the risks they take.

Risk premiums vary a great deal over time in response to new market information or changes in the economic environment or even changes in investor sentiment. When risk premiums increase or decrease, stocks and bonds and other assets have to be priced again. Investors react to the changes gradually and this creates trends.

Rules-based trend following strategies don’t predict, they react to what prices are telling us about supply and demand. More buyers than sellers or vice versa. Trend following strategies, in general, seek upside potential via an investment process that offers downside protection.

Trend following trading seeks to capture the majority of a market trend, up or down, for profit. Such strategies work in all major asset classes — stocks, bonds, currency and commodities. Click herefor our education series piece “Trend Following Works!”

Trade Signals is organized into four sections:

Trade Signals — Dashboard

Commentary

Charts with Explanations

Update on CMG Investment Indices

For informational purposes only… Not a recommendation to buy or sell any security.

Gold:

Commentary

Notable this week:

No major changes or updates.

Most notable is that March 9, 2019 marked the 10th anniversary of the current bull market – now the longest bull market move on record. Trend indicators continue to improve (you’ll find them below). The bond market remains in a buy signal. Investor sentiment is back in the “neutral” zone. Do take a quick look at the investor sentiment charts – the data will give you a feel for how they work.

I ran across the next chart and explanation in a recent John Murphy blog. John is a famous technical analyst and I like to keep an eye on his work. From his recent post:

LONG-TERM MOMENTUM IS ALSO WEAKENING… The monthly bars in Chart 2 show the uptrend in the S&P 500 that started exactly ten years ago. And that uptrend is still intact. The sharp selloff that took place during the fourth quarter of 2018 stayed above the rising trend-line drawn under its 2009, 2011, 2016 lows. That’s the good news. What may not be so good are signs that long-term momentum indicators are starting to weaken. The two lines in the upper box in Chart 2 plot the monthly Percent Price Oscillator (PPO). [The PPO measures percentage changes between two moving averages]. The PPO lines turned negative during the second half of last year when the faster red line fell below the slower blue line. And they remain negative. [The red histogram bars plotting the difference between the two PPO lines also remain in negative territory below their zero line (red circle)]. Secondly, and maybe more importantly, the 2018 peak in PPO is lower than the earlier peak formed at the end of 2014. That’s the first time that’s happened since the bull market began. In technical terms, that creates a potential “negative divergence” between the PPO lines and the S&P 500 which hit a new high last September. That raises the possibility that the ten-year bull market may have peaked in the fourth quarter and is now going through a major topping process. If the bull market in stocks is nearing an end, that could start the clock ticking on the nearly ten-year expansion in the U.S. economy. That might not prevent it from setting a new record for longevity this July, but it might diminish its chances for celebrating an eleventh anniversary in the summer of 2020.

Source: StockCharts.com

The S&P 500 is again trying to break above the 2,816 level that was the December 2018 high.

Important note: Not a recommendation for you to buy or sell any security. For information purposes only. Please talk with your advisor about needs, goals, time horizon and risk tolerances.

Charts with Explanations

Equity Market Charts

The Ned Davis Research CMG U.S. Large Cap Long/Flat Index measures “market breadth.” Market breadth is simply market activity, such as advances and declines, new highs and new lows, advancing and declining volume and price momentum and trend based upon the number of stocks in uptrends and downtrends. Technicians like “breadth” measurements for two main reasons:

Breadth thrusts are often present at the start of major bull markets.

Breadth nearly always weakens before prices do at a major peaks.

(Source: Ned Davis Research)

The NDR CMG U.S. Large Cap Long/Flat Index process measures market breadth by analyzing the overall technical strength across 24 Industry Groups (GICS). The process individually measures the trend of each of the industry groups, evaluating the rate of change in price momentum over short-term and long-term time frames and directional trend as determined by intermediate-term moving average crosses (for example, you may be familiar with the “golden cross” that compares the 50-day moving average price vs. the 200-day moving average price). The Index process also considers several mean-reverting indicators, such as deviation from trend and relative strength.

The most important line to follow in the red, white and blue chart below is the blue model equity line in the middle section of the chart. It is the combined total score across the 22 sub-industry sectors. Think of it as a “market breadth” combined weight of evidence measurement.

Here is how you read the chart:

Markets do best when the model equity blue line is moving up. Breadth nearly always weakens before prices do at major peaks… fewer and fewer stocks are moving the market higher (recall tech stocks in 1999 and financials in 2007).

When the model equity line is above 70, the index stays 100% invested.

When the model equity line is between 60 and 70 and the trend is moving higher, the index stays 100% invested. If the trend is lower, the index moves to 80% invested with 20% moving to T-Bills.

When the model equity line is between 50 and 60 and the trend is moving higher, the index stays 100% invested. If the trend is lower, the index moves to 40% invested with 60% moving to T-Bills. With greater breadth determination comes greater risk.

When the model equity line is below 50 and the trend is moving higher, the index is 100% invested. If the trend is lower, the index moves to 0% invested (“Flat”) with 100% moving to T-Bills. The most significant periods of risk comes when the majority of sub-industries are breaking down.

You’ll find the model’s statistical data at the bottom of the chart.

Down arrows show levels of exposures. Up arrows mark “B” or long signals.

Source: S&P Dow Jones Indices and Ned Davis Research. Click hereto learn more about how it works.Note: CMG Long/Flat Strategy performance may differ from index performance due to trade dates/times and costs.

We created a Long/Short version of the Index and the data is favorable. The model goes from 100% to 80% to 40% invested in the same way as the NDR CMG U.S. Large Cap Long/Flat Index; however, when the model trend line moves below 50, the process goes short U.S. Large Caps or short S&P 500 Index exposure.

Here’s the data (note in the lower left-hand chart the model returns – a several hundred basis point improvement in model return):

The process measures the intermediate-term trend in the S&P 500 Index. A bullish trend is identified when the blue 13-week smoothed moving average (“MA”) trend line rises above the 34-week smoothed MA trend line. A bearish trend is signaled when the blue line drops below the red line. You can see that this trend process has done a pretty good job at identifying the major cyclical (short-term) bull and bear market trends (note small red and blue arrows). In terms of risk management, a good stop-loss level may be at the point when the 13-week drops below the 34-week EMA with re-entry at the point the 13-week crosses above.

Click here to see “How I think about the 13/34-Week Exponential Moving Average.”

Bottom line: The 13-week shorter-term trend line has crossed below the 34-week longer-term trend line = bearish signal for equities.

3. Volume Demand vs. Volume Supply: Buy Signal – Bullish for Equities

When there are more buyers than sellers, prices move higher. When there are more sellers than buyers, prices decline. Supply and demand works that way in all things – real estate, oil, stock prices and all goods in a free market.

The Volume Demand vs. Volume Supply process looks at a smoothed total volume of declining issues versus a smoothed total volume of advancing issues using a broad market equity index. The performance, reflected in the chart below, is better when Vol Demand is better than Vol Supply. More buyers than sellers. This is a relatively slow-moving but important indicator.

The yellow highlights in the next two charts shows the current signal. Currently in a buy signal. Following is the model’s data 1981 to present (which includes the great bull market and the two bear markets since 2000):

Following is the model’s data 1997 to present (which includes the tail end of the great bull market and the two bear markets and the bull market that started in 2009):

Next is a look at what is known as the “Golden Cross.” Sell signals occur when the 50-day shorter-term moving average trend line drops below the longer-term 200-day moving average trend line. This trend-following process is also in a sell signal.

Read this chart in the same way as the S&P 500 200-day MA rule explained immediately above. 200-day MA line is dashed black line. Blue line is the NASDAQ Composite. Focus on upper right in chart and data box below.

Bottom line: Shaded area shows current signal. The 200-day MA trend is currently flattening. Stay tuned.

The indicators that comprise this reading are a combination of NDR’s Big Mo and the 10-Year Treasury yield. It highlights just how important Fed activity is to market performance. Readings range from +2 to -2.

Bottom line: when both the trend in interest rates (lower yields) and the trend in the overall market (the tape) are bullish, the market has historically performed best.

+2 readings have occurred about 12% of the time since 1980.

+1 readings have occurred approximately 25% of the time since 1980.

-2 readings have occurred approximately 6% of the time since 1980 and the performance during those periods, as shown in the chart is poor. “Watch out for -2!”

The bottom section of the above chart details the drawdown (“Max DD %”) history and a few other statistics. For example, if your $100,000 investment declines 10% to $90,000 before it again moves higher, your drawdown is 10%.

Barclays Aggregate Bond Total Return has a max drawdown of -14.12% vs. a max drawdown for the Zweig Bond Model of -5.06%.

You can compare the Barclays Aggregate Bond Index Total Return Max DD to the Model’s Max DD. Hoped for is a higher return and a lower DD. Also listed is the hypothetical growth of $1,000.

GPA% shows the hypothetical comparison of the Zweig Bond Model and the Barclays Agg Total Return index. The Model outperformed buying and holding the index by a wide margin.

Economic Indicators:

Select Recession Watch Indicators:

The average decline in the S&P 500 is approximately 37% during recessions. The last two recessions have given us greater than -50% each. I believe, given the fact that we have tripled up on the very same thing that caused the last recession (debt/leverage/Fed policy), the next recession will be equally or more challenging than the last two. Thus, my recession obsession. Following are my favorite recession watch indicators.

Bottom line: We are likely in a global recession. There is no current sign of recession in the U.S. in the coming six months. I remain data dependent.

Global Recession Probability Indicator – High Recession Risk

First, focus in on the blue model line. It plots the probability of recession based on leading indicators from 35 different countries (non-U.S.). The current reading is 90.94, meaning there is an 90.94% probability that we are in a global recession.

Note the red dotted line. Note the grey shaded bars that show periods in which the OECD said there was global recession (something known more than six months after the fact).

Bottom line: When the blue line rises above the red dotted line, the global economy was heading into or already likely in recession. A global recession has likely started,which is unfavorable for global equities.

Finally, focus in on the data box in the lower right section of the chart.

The Economy Based on the Stock Market Indicator –High U.S. Recession Risk

Focus on the up and down arrows. Economic expansion signals (up arrows) are generated when the S&P 500 Index rises by 3.8% above its five-month smoothed moving average line. Economic contraction signals are generated when the S&P 500 Index falls by 4.8% below its five-month smoothed moving average line.

Current signal is for “Contraction.” The most recent recession signal occurred on 12-31-2018. See down arrow upper right hand side of chart (yellow highlight).

Note the 80% “Correct Signals” in the top left corner of the chart. This this process has done a good job at signaling prior to recessions. Not perfect but pretty good.

Focus in on the up and down arrows. Down is a recession signal. Up is an expansion signal.

Expansion signals are generated when the Employment Trends Index rises by 0.4% from a low point.

Contraction signals are generated when the index falls by 4.8% from a high point.

Current signal indicates expansion. Last signal date in 2009.

Credit Conditions – Recession Indicator – Low U.S. Recession Risk

Focus in on the lower section of the chart. A drop below the green dotted line has preceded the last three recessions. A relatively small data set but the idea is that when lending tightens up “Credit Conditions Unfavorable”, recession tends to follow. Grey bars indicate periods of recession.

Currently, lending conditions are favorable.

U.S. Economy vs. Yield Curve – Low U.S. Recession Risk

Watch for a drop below the green dotted line.

Such drops below 0 is what is known as an inverted yield curve. It is when the 6-month Treasury Bill yield is higher than the longer-duration 10-year Treasury Note yield.

An inverted yield curve has preceded every recession since 1958 (lower section of chart).

No current signal of U.S. recession but nearing inversion.

Note that once the yield curve inverts, recession follows about a year later.

Gold:

The short-term and long-term gold indicators remain in buy signals.

13-week vs. 34-week exponential moving average: Buy Signal

Daily Gold Model: Sell Signal

Chart 1: 13-week vs. 34-week exponential moving average: Buy Signal

First, a look at the long-term cyclical trend in gold: Buy signals occur when the 13-week moving average trend line (blue line) crosses above the 34-week moving average trend line (red line). Sell signals occur when the 13-week moving average trend line (blue line) crosses below the slower moving 34-week moving average trend line (red line).

Why risk management?

Investing is a probability game. Limit downside: In the long run, it’s about the math. This next chart shows the “The Merciless Mathematics of Loss”. A 10% decline only requires an 11% subsequent return to get back to even. A 30% decline requires a 43% subsequent return to get back to even. A 50% decline requires a 100% subsequent return to get back to even. You can read more about it here.

I hope you find this information helpful. Thank you for your interest. It is appreciated.

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Ned Davis Research:

For years, I have subscribed to Ned Davis Research. They are an independent research firm. Their clients are institutional (professional) investor clients like CMG. They are one of the most respected research firms in the business.

They offer several levels of subscription. You can contact them directly at Ned Davis Research at 617-279-4878 to learn more. Please know that neither I nor CMG are compensated in any form. I’m just a big fan of their research and their way of thinking. As a side, Ned Davis authored one of my favorite books, Being Right or Making Money. A great book full of sound, practical advice.

Trade Signals History:

Trade Signals started after a colleague asked me if I could share my thoughts (trade signals) with him. A number of years ago, I found that putting pen to paper has really helped me in my investment management process and I hope that this research is of value to you in your investment process.

Every week, I share with you research I find valuable. No one indicator is perfect, but we believe risk can be assessed and should be managed. Some of this research helps to shape our thinking around risk management and it helps us think about how we might size various risks within the construct of a total portfolio. For example, overweight or underweight equities/fixed income and how much one should consider allocating to tactical/liquid alternative exposures (such as managed futures, global macro, long/short equity). When and what to hedge? Shorten or lengthen bond maturity exposure? We believe such risks can be managed and, to us, broad portfolio diversification is important. If you’d like to talk to us about how we use some of these indicators within our various investment strategies, please email me or email our sales team.

From an investment management perspective, I’ve followed, managed and written about trend following and investor sentiment for many years. I find that reviewing various sentiment, trend and other historically valuable rules-based indicators each week helps me to stay balanced and disciplined in allocating to the various risk sets that are included within a broadly diversified total portfolio solution.

My objective is to position in-line with the equity and fixed income market’s primary trends. I believe risk management is paramount in a long-term investment process. When to hedge, when to become more aggressive, etc.

Please note the comments at the bottom of this Trade Signals discussing a collared option strategy to hedge equity exposure using investor sentiment extremes is a guide to entry and exit. Go to www.cboe.com to learn more. Hire an experienced advisor to help you. Never write naked option positions. We do not offer options strategies at CMG.

A diversified investment portfolio is designed to meet pre-defined investment goals. It is often hard to stay the course when stress presents. That is when many investors make mistakes. Diversification means that not all investment risks perform at the same time. For example, managed futures and long/short funds have underperformed the last several years but are outperforming recently. We’d all like to be in the best performing areas all the time, but that is just not possible.

Major market events tend to present one or two times per decade. It is for this reason that a longer-term view can provide a useful perspective. We know that many investors incorrectly sold out of the markets during the tech bubble in 2000-2002 and again with record selling at the height of the 2008 great financial crisis. No one knows exactly how the current distress will play out.

For some time, I’ve been talking about the following: the issues in the high yield bond market, issues that can present post-QE and zero interest rate policy, issues with unmanageable debt in Europe, Japan and China and the issues a rising dollar may trigger as it relates to the $9 trillion in EM debt that was borrowed in dollars. As much as I’d like to think I do, I don’t know for sure which or how and when any of the above risks present and the degree to which they might play out.

What we can do is build portfolios that are diversified across a number of risk factors and market environments. We can identify periods in time to become more or less aggressively positioned (overweight when valuations are cheap and underweight when they are expensive). We can manage risk not only by the collections of ETFs and funds selected but also how we combine them together. Diversification brings meaningful improvement to portfolios designed to achieve a return objective over a long-term period of time.

I see the world of investing through a lens of risk and reward. Ultimately, it is far more important to minimize losses than to capture the best gains. Find me someone or some way to always capture the best gains – impossible, doesn’t exist. I’m friendly with some of the world’s greatest investors and none of them see themselves as perfect.

Over time, it’s really about understanding the power of compound interest. To this end, I wrote a paper entitled, The Merciless Math of Loss.

IMPORTANT DISCLOSURE INFORMATION

Investing involves risk. Past performance does not guarantee or indicate future results. Different types of investments involve varying degrees of risk. Therefore, it should not be assumed that future performance of any specific investment or investment strategy (including the investments and/or investment strategies recommended and/or undertaken by CMG Capital Management Group, Inc. or any of its related entities (collectively, “CMG”) will be profitable, equal any historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. No portion of the content should be construed as an offer or solicitation for the purchase or sale of any security. References to specific securities, investment programs or funds are for illustrative purposes only and are not intended to be, and should not be interpreted as recommendations to purchase or sell such securities.

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